Multipolarity: The New Global Economy

Transcription

1 ADVANCE EDITION Global Development Horizons 211 Multipolarity: The New Global Economy

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3 Global Development Horizons 211 Multipolarity: The New Global Economy ADVANCE EDITION

4 211 The International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 2433 Telephone: Internet: All rights reserved This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgement on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The International Bank for Reconstruction and Development / The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center Inc., 222 Rosewood Drive, Danvers, MA 1923, USA; telephone: ; fax: ; Internet: All other queries on rights and licenses, including subsidiary rights, should be addressed to the Offi ce of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 2433, USA; fax: ; pubrights@worldbank.org. This is an advance edition. Changes may be made to the content following the release of this edition. Such changes will be reflected in the final edition of the book. Cover image: Untitled, by Marc Pekala, 21 Cover design: Financial Communications, Inc., Bethesda, Maryland, United States

5 Contents Foreword xi OVERVIEW Emerging Growth Poles Will Alter the Balance of Global Growth Emerging-Market Multinationals Becoming a Potent Force in Reshaping the Process of Industrial Globalization Multipolar International Economy to Lead to a Larger Role for the Euro and, in the Long Term, for the Renminbi Multipolarity to Bring Benefits and New Challenges to the Developing World CHAPTER 1: Changing Growth Poles and Financial Positions Growth Poles and the Global Macroeconomy in the Postcrisis Era The Character of Growth in the Potential Emerging Economy Poles Dynamics of New Growth Poles: Implications for Domestic Output, Trade Flow Patterns, and Global Payments Imbalances Growth Poles and Multipolarity in the Future World Economy Policy Challenges and the Development Agenda Annexes Notes References CHAPTER 2: The Changing Global Corporate Landscape Emerging-Market Multinationals: Agents of Change in a Multipolar World The Growth and Globalization of Emerging-Market Corporate Finance Devising an Effective Framework for Cross-Border Investment Annexes GLOBAL DEVELOPMENT HORIZONS 211 v

6 vi Contents Global Development Horizons 211 Notes References CHAPTER 3: Multipolarity in International Finance International Currency Use Moving to a Multicurrency International Monetary System The Shape of Things to Come: Some Scenarios for a Future International Monetary System A Path toward Improved Institutional Management of a Multipolar World Conclusion Annexes Notes References Boxes 1.1 What is a growth pole? Defining poles in theory and practice Growth poles at the regional level Proximate and fundamental factors related to multidimensional growth polarity Suggestive evidence of successful transitions to consumption-driven growth Modeling the current account and growth process Multipolarity and commodities Empirical analysis of cross-border bilateral M&A flows from emerging economies The global expansion of cross-border financial transactions Data on international bond issues by firms Econometric estimations of corporate bond spreads The long history of failed negotiations over a multilateral investment framework Historically, one national currency has played a global role or at most, a few national currencies Benefits from currency internationalization The changing external financial position of developing countries Figures 1.1 Channels of growth spillovers from a growth pole Historical evolution of simple growth polarity, selected economies, Modern evolution of multidimensional growth polarity, selected advanced and emerging economies, Evolution of multipolarity, alternative indexes, Global distribution of growth poles, and Total factor productivity contribution to growth, selected potential poles Technological innovation, selected potential emerging economy poles Technological adoption, selected potential emerging economy poles, Export and consumption contribution to growth, selected potential poles

7 Global Development Horizons 211 Contents vii 1.1 Dominance of consumption to exports in growth, selected potential emerging economy poles, Evolution of saving, selected potential growth poles, by sector Incremental capital-output ratios, selected potential emerging economy poles, Investment shares of growth, selected potential emerging economy poles, Global distribution of research and development expenditure and researcher shares, average over Global distribution and selected evolution of consumption share by per capita income.. 34 B1.4.1 Evolution of consumption and export shares, Botswana and Mauritius Global real output shares, 21 and 225, baseline scenario Output growth for emerging and advanced economies, 15-year average, (historical) and (baseline scenario) Consumption and investment shares of output, current and potential growth poles, baseline Global import and export shares of global trade, advanced and emerging economies, baseline Net international investment positions, advanced and emerging economies, and selected net asset countries, baseline Evolution of multipolarity, economic size and simple polarity index, (projected) Shares of total LDC bilateral trade, selected advanced and emerging economies, Dominant LDC merchandise exports to and imports from selected emerging economies Net ODA from DAC countries to LDCs as share of LDC GDP, B1.6.1 Commodities price index, , and commodity intensity of demand, A.1 Nominal GDP overtaking scenarios, selected emerging and advanced economy poles, A.2 Real output growth in divergent productivity scenario, advanced economies and high- versus low-productivity emerging economies, A.3 Marginal productivity of capital and imports under various unbalanced growth scenarios, China, A.4 Investment share of output under various external balance scenarios, selected potential emerging economy poles, Total cross-border M&A deals by firms from advanced economies and emerging-market economies, Total cross-border greenfield investment by firms from advanced economies and emerging-market economies, Total cross-border greenfield investment and M&A deals by emerging-market firms, Geographic distribution of the top 1, firms by R&D spending Cross-border patents granted worldwide to residents of emerging economies, Technology and institutional environment in developing and developed countries Top source countries of emerging-market firms cross-border M&A deals in emerging economies and advanced economies

8 viii Contents Global Development Horizons Top destination countries for emerging- market firms cross-border M&A deals in emerging economies and advanced economies South-South cross-border greenfield investments and M&A deals, by value, South-North cross-border greenfield investments and M&A deals, by value, Cross-border M&A investment to low-income countries, B2.1.1 Selected bilateral M&A flows from home to host economies, Projected emerging-market outbound cross-border deals through B2.2.1 Global expansion of cross-border economic transactions, B2.2.2 Stronger growth in international trade of financial assets than in goods trade, New cross-listings by foreign firms on U.S. and European international stock exchanges, Share of cross-listed firms that announced acquisitions of foreign firms Equity financing raised on the LSE, NYSE, and NASDAQ by emerging-market acquirer firms, 1995 oct International bank lending to low income countries, International bond issues emanating from emerging economies, International debt financing by emerging-market firms, Average at-issue spreads of international private corporate bonds, by currency, Private bond spread versus GDP per capita Private bond spread versus sovereign risk rating U.S. dollar corporate bond spread to benchmarks, 2 1, average by year Total number of active bilateral investment treaties, Number of bilateral investment treaties signed by advanced economy countries, as of The number of newly signed South-South BITs rose rapidly in the 199s, ahead of the actual surge in South-South investment A.1 Source of ADR issues on U.S. exchanges, A.2 Breakdown of tallies for new foreign company listings on the LSE AIM, B3.1.1 Historical Timeline of Dominant International Currencies Currency denominations of banks international assets and international bonds outstanding, by percentage, Global foreign exchange market turnover, by currency (net of local, cross-border, and double counting), Composite indicator of international currency shares, Global currency shares relative to trade share and economic size B3.2.1 Gains from the international status of currency Foreign residents U.S. asset holdings, U.S. balance of payments, The geographic distribution of trade concentration relative to China, the European Union, and the United States, 25 9 period average Share of global manufacturing exports B3.3.1 Evolution of net international investment positions, advanced and emerging economies,

9 Global Development Horizons 211 Contents ix 3.9 Implied U.S. fiscal balances and global economic sizes, dollar standard and multipolar currencies scenarios Membership in major international organizations, Macroeconomic policy disparities, selected actual and potential growth poles among advanced and emerging economies Exchange rate arrangements of developing countries, 2 and SDRs as a percentage of the world s foreign exchange reserves, Distribution of foreign exchange reserves, 1999 and Tables 1.1 Multidimensional polarity index, top 15 economies, 24 8 average B1.2.1 Regional simple polarity index, top three countries, 24 8 average Current account balances, current and potential growth poles, Key perturbations for alternative growth and external balance scenarios Measures of growth poles, top 15 countries, baseline average A.1 Principal components index (with and without migration subindex) for growth poles, top 1 economies, 24 8 average A.2 Estimates for proximate determinants of growth polarity A.3 Estimates for fundamental determinants of growth polarity A.4 Correlations for consumption, investment, and exports with output, and changes in consumption, investment, and exports with change in output, current and potential pole A.5 Estimates for empirical current account balances model, by country group A.6 Additional current account balances, potential poles, Regional distribution of cross-border mergers and acquisitions, by number of deals and value, Top emerging-market multinationals in cross-border mergers and acquistions, by number of deals, B2.4.1 Detailed econometric results for regressions on spread determinants A.1 Summary statistics of corporate bond issuance by emerging-market countries, A.2 Definitions of key variables included in the database A.3 Determinants of cross-border outbound M&A investments Currency shares of foreign exchange reserve holdings, by percentage, Importance of selected national financial markets International debt securities outstanding, by currency, Renminbi local currency swap arrangements, July Currency denominations of the external balance sheets of the United States and China, end A.1 Estimates of long-run global money demand for the U.S. dollar, euro, pound sterling, and yen A.2 Principle factor analysis of international currency use

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11 Foreword THE WORLD ECONOMY IS IN THE midst of a transformative change. One of the most visible outcomes of this transformation is the rise of a number of dynamic emerging market countries to the helm of the global economy. It is likely that, by 225, emerging economies such as Brazil, China, India, Indonesia, and the Russian Federation will be major contributors to global growth, alongside the advanced economies. As they pursue growth opportunities abroad and encouraged by improved policies at home, corporations based in emerging markets are playing an increasingly prominent role in global business and cross_border investment. The international monetary system is likely to cease being dominated by a single currency. Emerging-market countries, where two-thirds of offi cial foreign exchange reserves are currently held and whose sovereign wealth funds and other pools of capital are increasingly important sources of international investment, will become key players in fi nancial markets. In short, a new world order with a more diffuse distribution of economic power is emerging thus the shift toward multipolarity. Throughout the course of history, major economic transitions have always presented challenges, as they involve large uncertainties surrounding identification of emerging global issues of systemic importance and development of appropriate policy and institutional responses. It is in this context that the World Bank is launching a new report, Global Development Horizons (GDH). 1 The new report serves as a vehicle for stimulating new thinking and research on anticipated structural changes in the global economic landscape. To retain this forwardlooking orientation and to serve the World Bank Group s mandate of development and poverty alleviation, it is envisaged that future editions of GDH will be dedicated to themes of importance to the emerging development agenda and global economic governance, including changing global income inequality, increasing economic insecurity, global population aging, and the future shape of development finance. The inaugural edition of GDH addresses the broad trend toward multipolarity in the global economy, particularly as it relates to structural changes in growth dynamics, corporate investment, and international monetary and fi nancial arrangements. Multipolarity, of course, has different interpretations within different spheres of contemporary international relations. In international politics, where much of the discussion has been focused, the debate centers on the potential for a nonpolar world, in which numerous national concentrations of power exist but no single center dominates (as opposed to the bipolar global political environment that defined the Cold War era). In the realm of international economics, multipolarity meaning more than two dominant growth poles has at times been a key feature of the global system. But at no time in modern history have so many developing countries been at the forefront of a multipolar economic system. This pattern is now set to change. Within the next two decades, the rise of emerging economies will inevitably have major implications for the global economic and geopolitical landscape. 1. GDH now contains the thematic analysis that previously appeared in Global Development Finance and Global Economic Prospects. Global Economic Prospects will continue to be produced, but without the thematic chapters, and Global Development Finance will be focused on data. GLOBAL DEVELOPMENT HORIZONS 211 xi

12 xii Foreword Global Development Horizons 211 In a world of progressively more multipolar economic growth and fi nancial centers, policy makers will need to equip themselves with the tools and capabilities to effectively capitalize on opportunities while simultaneously safeguarding their economies against the risks that remain stubbornly high as the global economy struggles to find a stable footing. Within the realm of immediate concerns, the tragic earthquake and tsunami that hit Japan in March 211, the political turmoil gripping much of the Middle East and North Africa, and the financial tremors emanating from the European sovereign debt crisis are all likely to exact a heavy toll on global fi nancial markets and growth. Seen against the backdrop of a sub-par global growth trajectory, high levels of unemployment in many advanced and developing economies, and rising infl ationary pressures in many emerging and low-income economies, these events call for further bold, concrete actions to shore up confidence and establish the underpinning for bankers to lend, and for businesses to invest in equipment and technology that will boost productivity, create jobs, and generate long-term growth. Indeed, it is through rising investment and economic growth that productive jobs will be created to absorb the large youth cohort in the Middle East and North Africa region and elsewhere, that earthquake-shattered parts of Japan will be rebuilt, and that fi scal consolidation in the United States and Europe will become more achievable. The transformation of global patterns of economic growth is also driving a change in the international monetary system. At the current juncture, the U.S. dollar remains the most important international currency, despite a slow decline in its role since the late 199s and abandonment nearly forty years ago of the Bretton Woods system of fi xed exchange rates (in which the dollar officially anchored the world s currencies). But the dollar now faces growing competition in the international currency space. Chief within this space is the euro, which has gained ground in recent years as a currency in which goods are invoiced and official reserves are held, while the yen and pound represent only single digit shares of official reserves In the longer term, the size and dynamism of China s economy and the rapid globalization of its corporations and banks will position the renminbi to take on a more important international role. By 225, the most probable global currency scenario will be a multipolar one centered around the dollar, euro, and renminbi. This scenario is supported by the likelihood that the United States, the euro area, and China will constitute the three major growth poles by that time, providing stimulus to other countries through trade, finance, and technology channels and thereby creating international demand for their currencies. The potential for rising competition among power centers that is inherent in the shift to a more multipolar world makes strengthening policy coordination across economies developing and developed critical to reducing the risks of political and economic instability. In the years leading up to the financial crisis, the role of international economic policy making was confi ned to managing the symptoms of incompatible macroeconomic policies, such as exchange rate misalignments and payments imbalances. As capital markets have been liberalized and exchange rates made more flexible, balance of payments constraints on national economies have been considerably eased, shifting policy coordination toward the more politically sensitive spheres of domestic monetary and fiscal policy. For its part, the international fi nancial community must recognize that it has a complex burden to shoulder in ensuring that the least developed countries (LDCs) are guarded against the volatility that could accompany the transition to a multipolar order. Many LDCs are heavily reliant on external demand for growth and, hence, their ability to manage their external relations becomes critical. For those with floating exchange rate regimes, a critical element would be the development of the necessary institutional policy frameworks, market microstructure, and fi nancial institutions that can ensure the smooth functioning of foreign exchange markets. Aid and technical assistance from international fi nancial institutions have the potential to cushion volatility in these economies as they adapt to the global forces involved in the transition to a multipolar world.

13 Global Development Horizons 211 Foreword xiii Finally, the World Bank believes that a publication geared toward stimulating new thinking and research on the implications of a changing global landscape should embed change in its own format and design. Thus, GDH will consist of both a hard copy publication and a companion website ( that will serve as an extension of the paper publication. This website will be a platform for the report s underlying data, methodology, blog postings, and relevant background papers. The site will also include an interactive feature that will allow visitors to explore the scenarios described in GDH. This is in line with the Bank s agenda to democratize development via our Open Data Initiative and greater emphasis on open knowledge exchange ( In the future, the site will also serve as a repository of related research papers from the broader development community, as well as a vehicle for interactive debate and networking with various think tanks, business associations, and policy establishments concerned with long-term global economic change and its implications for development policy and discourse. Justin Yifu Lin Chief Economist and Senior Vice President The World Bank

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15 Overview SWEEPING CHANGES ARE AFOOT in the global economy. As the second decade of the 21st century unfolds and the world exits from the 28 9 financial crisis, the growing clout of emerging markets is paving the way for a world economy with an increasingly multipolar character. The distribution of global growth will become more diffuse, with no single country dominating the global economic scene. The seeds of this change were planted some time ago. Over the past two decades, the world has witnessed emerging economies rise to become a powerful force in international production, trade, and finance. Developing countries share of international trade flows has risen steadily, from 3 percent in 1995 to an estimated 45 percent in 21. Much of this rise has been due to an expansion of trade not between developed countries and developing countries, but among developing countries. Similarly, more than one-third of foreign direct investment in developing countries currently originates in other developing countries. Emerging economies have also increased their financial holdings and wealth. Emerging and developing countries now hold two-thirds of all official foreign exchange reserves (a reversal in the pattern of the previous decade, when advanced economies held two-thirds of all reserves), and sovereign wealth funds and other pools of capital in developing countries have become key sources of international investment. At the same time, the risk of investing in emerging economies has declined dramatically. Borrowers such as Brazil, Chile, and Turkey now pay lower interest rates on their sovereign debts than do several European countries. As investors and multinational companies increase their exposure to fast-growing emerging economies, international demand for emerging-economy currencies will grow, making way for a global monetary system with more than one dominant currency. The growing strength of emerging economies also affects the policy environment, necessitating more inclusive global economic policy making in the future. This broad evolution under way in the global economy is not without precedent. Throughout the course of history, paradigms of economic power have been drawn and redrawn according to the rise and fall of states with the greatest capability to drive global growth and provide stimulus to other countries through cross-border commercial and fi nancial engagements. In the fi rst half of the second millennium, China and India were the world s predominant growth poles. The Industrial Revolution brought Western European economies to the forefront. In the post World War II era, the United States was the predominant force in the global economy, with Germany and Japan also playing leading roles. In more recent years, the global economy has begun yet another major transition, one in which economic influence has clearly become more dispersed than at any time since the late 196s. Just as important, developing countries have never been at the forefront of multipolarity in economic affairs. During the forecast period of Global Development Horizons (GDH) 211 from 211 to 225 the rise of emerging economies will inevitably have major implications for the global economic and geopolitical hierarchy, just as similar transformations have had in the past. Increased diffusion of global growth and economic power raises the imperative of collective management as the most viable mechanism for addressing the challenges of a multipolar world economy. The key differences that the management of a multipolar global economy will present Global Development Horizons 211 1

16 2 Overview Global Development Horizons 211 relative to the postwar era of the U.S.-centered global economic order relate to the distribution of the costs and responsibilities of system maintenance and the mechanisms for sharing the special privileges and benefits associated with being a global growth pole. In the postwar era, the global economic order was built on a complementary set of tacit economic and security arrangements between the United States and its core partners, with developing countries playing a peripheral role in formulating their macroeconomic policies and establishing economic links with an eye toward benefiting from the growth dynamism in developed countries. In exchange for the United States assuming the responsibilities of system maintenance, serving as the open market of last resort, and issuing the most widely used international reserve currency, its key partners, Western European countries and Japan, acquiesced to the special privileges enjoyed by the United States seigniorage gains, domestic macroeconomic policy autonomy, and balance of payments flexibility. Broadly, this arrangement still holds, though hints of its erosion became evident some time ago. For example, the end of the postwar gold exchange standard in 1971 heralded a new era of floating currencies (formalized by the Jamaica Agreement in 1976), a trend that has not been limited to developed countries. Particularly since the East Asian financial crisis of , developing countries have increasingly floated their currencies. Changes in currency use have also occurred. As Europe has followed a trajectory of ever-increasing economic integration, the euro has come to represent a growing proportion of international transactions and foreign exchange reserve holdings. At the same time, developing economies increased trade flows and the gradual opening of their economies to foreign capital have benefited developing economies handsomely, boosting their growth potential and tying their economic and financial stakes to the continuation of a liberal global order. In the unfolding global economic environment, in which a number of dynamic emerging economies are evolving to take their place at the helm of the global economy, the management of multipolarity demands a reappraisal of three pillars of the conventional approach to global economic governance the link between economic power concentration and stability, the North-South axis of capital fl ows, and the centrality of the U.S. dollar in the global monetary system. Such a reappraisal offers much in advancing the debate on the future course of international development policy and discourse. In anticipation of the shape of the future global economy, this first edition of Global Development Horizons aims to map out the emerging policy agenda and challenges that an increasingly multipolar world economy poses for developing countries. Emerging Growth Poles Will Alter the Balance of Global Growth The coming decades will see global economic growth increasingly being generated in emerging economies. By 225, global economic growth will predominantly be generated in emerging economies. Although many high-income countries are only gradually recovering from the financial crisis, most developing countries have swiftly returned to their fast precrisis growth trend. China was one of the fi rst economies to emerge from the crisis, and it returned quickly to around 1 percent growth. India experienced a stronger contraction, but also attained more than 1 percent growth in 21, and the government is putting in place an ambitious new Five Year Plan (with improved policies and necessary investment programs) to keep growth at that level. Latin America sharply rebounded in 21, after contracting sharply in 29. Even Sub-Saharan Africa is expected to return quickly to almost 6 percent annual growth, similar to its performance in the years before the crisis. Even in the absence of such exceptionally high growth rates in the developing world, the balance of global growth is expected to shift dramatically. The changing role of developing countries will come with major transformations to their economies, corporate sectors, and financial systems. These changes are likely to occur in a wide variety of scenarios. The baseline scenario considered in GDH 211 which is derived from longerterm historical trends and from forward-looking

17 Global Development Horizons 211 Overview 3 components such as anticipated changes in demography, labor force growth, saving patterns, and educational levels offers a lens into the possible transformations to come. This scenario envisions average growth over the next 15 years that will be substantially lower than the highs of 21. However, emerging economies will still, collectively, expand by an average of 4.7 percent per year (more than twice the developed world s 2.3 percent rate) between 211 and 225. (Given the considerable uncertainty underlying long-term growth projections, the baseline scenario includes error bands to emphasize the wide range of possible outcomes). By 225, six major emerging economies Brazil, China, India, Indonesia, the Republic of Korea, and the Russian Federation will collectively account for more than half of all global growth. Several of these economies will become key drivers of global growth, alongside advanced economies. This new global economy, in which the centers of growth are distributed across both developed and emerging economies, is what GDH 211 envisions as a multipolar world. Altering this balance calls for productivity growth in emerging economies and realignment of demand away from external sources Even with a moderation of growth in developing countries, successful realization of the baseline scenario presented in GDH 211 is dependent on several important changes to the character of growth in emerging economies. In particular, strong future growth performance of emerging markets depends critically on these economies ability to sustain improvements in technological dynamism often referred to as total factor productivity (TFP) and to successfully transition toward internal sources of demand. Historically, economic progress in emerging economies has followed one of two paths. The first, which characterizes economies such as China, India, and Russia, is one in which TFP growth is a major contributor to economic growth. The second path, which has recently been common among the economies of Latin America and Southeast Asia, is one in which growth is led by the rapid mobilization of factors of production. Yet even in the former case, TFP growth has been largely due to the rapid adoption of existing technologies, economywide factor reallocation, and improvements in institutional governance, rather than progress in pure innovative capacity. The long-run viability of fast-paced growth in emerging economies will thus depend, in part, on the ability of emerging economies to enhance their indigenous innovation through investments in human capital and through the creation of appropriate institutional mechanisms to stimulate expenditure on research and development (R&D). Innovation and innovative capacity are already rising in emerging economies. Since 2, China and India have invested heavily in R&D; expenditures on R&D accounted for 1.4 percent of gross domestic product (GDP) in China and.8 percent in India, about an order of magnitude greater than that shown by peer economies in their respective income groups. The siting of major research facilities in China by Microsoft, the invention of the Nano microcar by Indian firm Tata, and the continued string of aeronautical breakthroughs in Russia suggest the emerging-economy giants strong potential for fostering growth through technological advancement. Rapid growth in the major emerging economies will also need to be accompanied by a realignment of growth away from external sources and toward internal demand a process that is under way in many cases. In China, for example, consumption is projected to rise from the current 41 percent of national income to 55 percent by 225, much closer to the level of developed countries. Similar increases are also likely to occur in the emerging economies of Eastern Europe. Latin American economies, where the consumption share of income is already 65 percent and is expected to remain at that level, will be the exception to this trend. The sharpest declines in savings rates are likely in East Asian and Eastern European economies, where population aging will be at a more advanced stage. In Eastern Europe, rising levels of consumption are likely to occur concomitantly with relative declines in investment shares, consistent with the declining labor force in several countries. As a result, current account defi cits could narrow in

18 4 Overview Global Development Horizons 211 those countries. Conversely, account surpluses in several Asian countries could be reduced with the declining savings rates. Together with rising domestic savings in the United States after the fi nancial crisis, the more prominent role of emerging economies coincides with a narrowing of global imbalances, which indeed is part of the baseline scenario. Sustaining higher consumption shares of output in emerging economies will be key in consolidating the transition from externally driven to internally driven growth and will require an expansion of the middle class, which, in turn, will call for emerging-market policy makers to usher in broad fi nancial sector development and to improve domestic social safety nets. To meet demand for more diverse consumption goods, increasing numbers of small and medium enterprises are required, together with open trade relations. As the international trade shares of the emerging and developed world converge, global wealth and asset holdings will shift toward emerging economies As a group, emerging economies are likely to experience significant increases in their international trade flows by 225, in terms of both imports and exports. The value of Indonesia s exports, for example, is likely to double between 21 and 225, while the value of its imports is expected to be more than one-and-a-half times higher by 225. Global trade is forecast to expand as a share of global output over the same time period, from 49.9 percent of output to 53.6 percent. These current account paths mean that major emerging economies are likely to collectively take on a large and rising net asset international position (albeit at a diminishing rate) in their holdings of investments in developed economies (which, in turn, are expected to build equally large net liability positions). Global wealth and asset holdings will thus shift further toward emerging economies with surpluses, such as China and major oil exporters in the Middle East. This adjustment is already refl ected in the current financial landscape: International reserves held by emerging economies topped $7.4 trillion in 21 (approximately three times the $2.1 trillion in reserves held by advanced economies), and the share of cross-border mergers and acquisitions (M&A) by firms based in emerging economies in 21 was 29 percent ($47 billion) of the global total. The road ahead for emerging economies while cautiously positive will nevertheless entail downside risks of both a short- and a long-term nature. If economies with historically low TFP contributions are unable to raise their productivity levels through institutional reform and technological innovation, the existing twotrack global economy may fracture even further into a slowly divergent growth path between advanced economies, low-productivity developing economies, and high-productivity developing economies. Similarly, if outward-oriented emerging economies with weak internal demands are not successful in increasing their consumption share, capital in these economies may eventually be channeled toward increasingly unproductive, low-yielding investments. The run-up in commodity prices since 23 may also become persistent, which could potentially derail growth in developing countries that are especially commodity intensive. On the upside, if emerging economies successfully navigate their rising per capita incomes, provide necessary infrastructural improvements, and facilitate corporate sector reform, the baseline scenario may underestimate emerging economies future growth potential. Finally, unexpected economic and geopolitical developments may introduce fundamental uncertainty of a nature that is impossible to develop scenarios for. Emerging-Market Multinationals Becoming a Potent Force in Reshaping the Process of Industrial Globalization Long relegated to second-tier status, emergingmarket companies are becoming powerful forces and agents of change in the global industrial and fi nancial landscape. Trends in foreign direct investment (FDI) flows are one indication of this shifting status. Between 1997 and 23,

19 Global Development Horizons 211 Overview 5 companies based in emerging economies engaged in cross-border investment through M&A deals of $189 billion, or 4 percent of the value of all global M&A investments over the period. Between 24 and 21, that amount increased to $1.1 trillion 17 percent of the global total. Since 23, approximately 5, firms based in emerging markets have established a global presence through 12,516 greenfi eld investments of $1.72 trillion. More than one-third of FDI inflows to developing countries now originate in other developing countries: Of the 11,113 crossborder M&A deals announced worldwide in 21, 5,623 more than half involved emerging-market companies, either as buyers or as takeover targets by advanced-country fi rms. As they venture overseas, companies based in emerging markets tend to seek assets that will help them accomplish one or more of several goals: diversification of their growth, a larger global market share, exploitation of growth opportunities not available in their domestic economies, or freedom from an unfavorable domestic economic climate. As they pursue growth opportunities abroad, corporations based in emerging markets play an increasingly prominent role in global business, competing with firms based in advanced countries for natural resources, technology, and access to international markets. Many emerging-market fi rms often have an advantage over advanced-country firms in navigating difficult policy environments in other developing countries, because they have experienced similar conditions in their home countries. These two trends, together with the overall strengthening of South- South trade links, will ensure that South-South investment continues to expand. Further, M&A activity by emerging-market firms in developing countries is on the rise and is becoming an important source of FDI. Because such transactions typically occur within close geographical proximity, they will not only deepen regional economic ties, but also accelerate the integration of low-income countries into the global economy. Emerging-market fi rms have also been active in South-North acquisitions, especially in advanced economies with sophisticated equity markets and favorable growth prospects. The annual value of cross- border M&A transactions undertaken by emerging-market fi rms is forecast to more than double by 225, while the annual number of cross-border M&A deals is expected to more than triple (from fewer than 2,5 in 211 to almost 8, in 225). This trend outpaces the underlying GDP growth rates in emerging-market firms home countries. The development of emerging-market firms into a potent force for globalization in their own right will have important implications for crossborder capital formation, technology generation and diffusion, and fi nancing of commercial activities. A number of innovative and dynamic emerging-market firms are on a path toward dominating their industrial sectors globally much in the same way that companies based in advanced economies have done over the past half century. Many emerging-market firms have already begun overtaking their advanced-country competitors in terms of the priority accorded to developing innovative technologies and industrial processes, with 114 firms from emerging economies ranking among the top 1, fi rms worldwide by R&D spending as of 29, twice as many as fi ve years earlier. This is a particularly noteworthy accomplishment given that the private sector traditionally has not been the main fi nancier of R&D in developing countries. In 225, a luxury sedan is as likely to be a Hyundai or Tata as a Mercedes or Lexus, is as likely to be powered with fuel from Lukoil or Pertamina as from ExxonMobil or BP, and is as likely to be fi nanced by China s ICBC (Industrial and Commercial Bank of China Ltd.) or Brazil s Itaú as by Citi or BNP Paribas. There are strong signs of mutually reinforcing links between commercial and financial globalization The shift in economic and financial power toward the developing world is also reshaping cross-border corporate finance, transforming emerging-market firms into significant participants in international capital markets. The progress of a growing number of developing countries in improving the soundness and transparency of domestic institutions and policies has enabled their fi rms to gain increased access to international bond and equity markets, and at better terms, in their efforts to expand globally. Nearly two-thirds of emerging-market

20 6 Overview Global Development Horizons 211 firms that have been active acquirers since the late 199s those fi rms that have undertaken 1 or more acquisitions have tapped international markets to access one or more forms of fi nancing through syndicated loans, bond issues, and equity listings. As evidence of the mutually reinforcing links between commercial and financial globalization, a growing number of emerging-market firms undertake at least one cross- border acquisition within two years of accessing international capital markets. International bond issuance, in particular, by borrowers based in emerging markets has grown dramatically since the mid-199s and is now one of the main sources of capital inflows for those countries. Since 1995, a large number of emerging private companies have engaged in high-profile global bond market transactions, with 8 of them issuing bonds over $1 billion each, of which 1 were issuances of over $2 billion. Some prominent issuers include Petrobras International Finance Company of Brazil, América Móvil of Mexico, Novelis Inc of India, and VTB bank of Russia. Over the next decade and beyond, there is likely to be significant scope for emerging-market companies to further expand their access to international capital markets and at more favorable terms. In emerging-market economies such as Brazil, Chile, and Mexico, where local capital markets have seen considerable growth and maturity in recent years, companies have the capacity to fund their growth through a more balanced mix of local and international capital market issuance. Furthermore, in some emerging growth poles, particularly those in Asia, signs already exist that their local capital markets are evolving into regional fi nancing hubs. During the next decade and beyond, as local consumer demand continues to rise in the fastest-growing emerging markets and as local capital markets in those countries become deeper and better regulated, manufacturing and consumer goods firms based in developed countries can be expected to also seek access to capital markets in emerging markets. Crosslistings of securities by developed-country fi rms, although initially motivated by the desire to raise their firms brand recognition, will be followed by issues that tap large pools of available savings in emerging markets. From a policy perspective, the growing role and influence of emerging-market firms in global investment and fi nance may make it more possible and indeed, critical to move forward with the sort of multilateral framework for regulating cross-border investment that has been derailed several times since the 192s. In contrast to international trade and monetary relations, no multilateral regime exists to promote and govern cross-border investment. Instead, the surge of bilateral investment treaties (BITs) more than 2,275 BITs were in place in 27, up from just 25 in the mid-198s has provided the most widely used mechanism for interstate negotiation over cross-border investment terms, including access to international arbitration of disputes. Though BITs have proven to be suboptimal from an economic point of view, there are reasons to believe that their proliferation and the associated experience of formulating, negotiating, and implementing them across a large number of developed and developing countries have set the stage for transition into a multilateral framework. The elimination of investment restrictions through BITs, for example, may be supportive of more general multilateral liberalization efforts. Moreover, BITs have also set the stage for complementary institutional advancements at the global level. Indeed, the International Centre for the Settlement of Investment Disputes (ICSID) has experienced growing demand for cross-border investment dispute settlement services cases registered with the ICSID averaged 25 per year between 21 and 21, up from an average of about two cases per year between 1981 and 199. This increase in demand has allowed the maturation of an institutional infrastructure that is well positioned to serve as an important foundation, especially on legal aspects, for a multilateral framework in the future. Multipolar International Economy to Lead to a Larger Role for the Euro and, in the Long Term, for the Renminbi Rapid growth in emerging-market economies has led to enormous wealth creation and substantial